Is RBI ‘robbing’ banks to pay govt?

It is interesting to note that public sector banks (PSBs), which are expected to do banking on “commercial” lines, incur losses while the Reserve Bank of India, the banking regulator, generates high income over expenditure year after year.

Can one justify this paradoxical situation of high level of surplus/profits of a regulator and the corresponding high level of losses of commercial banks? In which other country can one see this phenomenon?

During FY17-18, out of the 21 state-owned banks, only two banks — Indian Bank and Vijaya Bank — posted profits. The net losses of all PSBs was around Rs 85,370 crore. The huge losses are mainly on account of provisioning and write-offs arising out of loan assets. Stressed assets [gross non-performing assets plus restructured standard advances] in the banking system was at 12.1% of gross advances at end-March 2018, impacting increase in provisioning against NPAs.

Treasury losses on account of hardening of yields further eroded the profitability of the banks. As per the stress tests carried out by RBI, the gross NPA ratio of scheduled commercial banks is expected to rise in 2018-19. So, one cannot expect improvement in profitability of PSBs during the current year also.

The balance sheet of RBI is largely a reflection of the activities carried out in pursuance of its currency issue function as well as monetary policy and reserve management objectives. Even though PSBs are not in a position to support the central government by providing reasonable returns (dividends) on government holding in these banks, RBI has been transferring hefty amounts to the government — on a capital of just Rs 5 crore.

Under the Reserve Bank of India Act, after making certain provisions, the balance of the profits is to be paid to the Centre. As per the RBI Annual Report for FY18 published in August, the surplus transferred to the Centre was Rs 50,000 crore (increase of 63%) as against Rs 30,659 crore for FY17 (low due to Demonetisation effect). The surplus transferred was much higher in earlier years: FY16: Rs 65,876 crore and in FY15: Rs 65,896 crore.

The higher surplus during FY18 is on account of 26.63% increase in income and 9.24% reduction in expenditure — mainly in expenditure incurred in printing of notes. Almost all income of RBI is in the nature of interest, that is, income derived from fund deployment.

The efficacy of the Cash Reserve Ratio (CRR) as a monetary control tool and strengthening of banking structure is well recognised. The RBI is authorised to prescribe CRR without any floor/ceiling rate for securing monitory stability. From 2007 onwards, no interest is paid on CRR balances. At the same time, banks are required to pay interest to the depositors, other than on Current Accounts.

CRR requirements

To meet current CRR requirements of 4% of the Net Demand and Term Liabilities and to meet payment and settlement of transactions, banks keep substantial funds with RBI. To avoid the risk of penalties on account of not meeting the CRR requirements, banks do keep a little more than the amount required.

During FY18, the balance maintained was 101.1% of CRR prescription. The amount kept by banks with RBI in Current Accounts is more than Rs 5 lakh crore (Rs 5,07,095 crore in FY18) and about 94% of those deposits are from Scheduled Commercial Banks.

Additionally, the balance in DEA Fund (amount representing transfer of unclaimed deposits, that is, not claimed for a period of 10 years from the maturity date of term deposits or last date of operation in case of operative accounts) is Rs 19,567 crore. It is true that RBI pays interest at 3.5% when claims are made by the depositors/nominees/legal heirs. Therefore, the aggregate amount with RBI from banks is about Rs 5,26,662 crore.

Even at a current Marginal Standing Facility Rate (MSF) at 6.75%, the yearly interest income to RBI on account of these “free funds” (say at Rs 5 lakh crore) is Rs 33,750 crore. Therefore, around 67% of the surplus of Rs 50,000 crore or 46% of the interest income (interest income Rs 73,871) is on account of compulsory funds kept by banks with RBI.

The notional loss on account of CRR is factored by banks in computing MCLR (Marginal Cost of Funds-based Lending Rate) in the form of “negative carry on account of CRR” and the lending rates of the banks gets marginally jacked up.

Perhaps a proper compensation on CRR balances by RBI to banks, may be at Repo rate or even at 3.5% (SB) rate, would result in marginal reduction in lending rates and, more importantly, will improve banks’ profitability.

Is it not time for RBI to transmit a part of excess income/legitimate dues to the banks in the form of interest on CRR, instead of transferring massive amounts to the government year after year? One should also understand that recapitalisation of PSBs by the government is only indirect sharing of the funds the government got on account of non-payment of interest on CRR balances.

(The writer teaches banking at ICICI Manipal Academy, Bengaluru)